IRS Cracking Down on IRAs

From InvestingDaily.com:

The IRS is taking a fresh interest in IRAs.

Individual Retirement Arrangements (IRAs) hold trillions of dollars. These dollars are sheltered from taxes, for the most part until the owners decide to take distributions. The IRS discovered, however, that IRAs are a rich goldmine of unpaid taxes and penalties, because taxpayers are not following all the rules. Recently the IRS studied a sample of IRA owners over age 70½ and found a high percentage of those with large IRAs were not taking their required minimum distributions (RMDs).

Here’s what you need to know to avoid problems with the IRS.

Congress suspended RMDs for 2009 to help IRA owners who didn’t need the distributions to let their balances recover from the investment declines of 2008. But the suspension was for only one year, and there’s no indication Congress plans to suspend RMDs retroactively for 2010 or for any future year.

The IRS receives up to two reports from IRA custodians for each IRA with an owner over age 70½. One report is Form 1099-R that reports the amount of distributions for the year from every IRA. The IRA owner also receives a copy of this form.

The other report is Form 5498. This provides the IRS with basic information about the owner of each IRA: Name, address, Social Security number, IRA balance, and whether an RMD was required for the year.

In a recent study the IRS compared the two forms for a sample of taxpayers and found a high percentage whose 5498 indicated an RMD was required did not also have a 1099-R filed. The lack of a 1099-R indicated the IRA owner failed to take an RMD. Further investigation revealed that a number of the IRA owners hadn’t broken the rules.

5 Ways Retirement Tax Breaks Will Change in 2011

Earlier in the week the IRS announced the adjustments to pension plan limitations in 2011, which will have an impact on a handful of retirement plans popular among American taxpayers. US News.com put together a list of the top five retirement tax breaks that will be affected by the IRS' recent announcement. You can find a few items from their list below, or the full text here.

401(k)s. The savings limits for employer-based retirement accounts are not increasing next year because inflation was too low to trigger an increase. The cost-of-living index used to calculate increases in 401(k) savings limits is currently greater than it was in 2009, but it is still less than the measurement for the third quarter of 2008. The maximum amount investors can contribute to 401(k)s will not be raised until the September inflation measurement climbs above where is was in 2008. Contribution limits cannot be reduced under current law.

Traditional IRAs. Certain income ceilings determine who is eligible for a tax break for contributing to an IRA. Individuals who have a retirement plan at work can contribute the full amount to an IRA until their modified adjusted gross income (AGI) reaches $56,000. The amount eligible for tax deferral is then gradually phased out until income reaches $66,000 in 2011, the same amount as this year. However, married couples filing jointly will get higher income limits next year. For a spouse who participates in a retirement plan at work the income phase-out range will be $90,000 to $110,000 in 2011, up from $89,000 to $109,000 this year. For IRA owners who do not have access to a retirement account at work, but are married to someone who does, the deduction will be phased out if the couple’s income is between $169,000 and $179,000, up from $167,000 and $177,000 this year.

Roth IRAs. More high income retirement savers will be eligible to make Roth IRA contributions next year. Married couples filing jointly can contribute to a Roth IRA until their AGI reaches between $169,000 and 179,000 next year, up from $167,000 to $177,000 in 2010. The AGI phase-out range for singles and heads of household will increase from $105,000 to $120,000 this year to between $107,000 and $122,000 in 2011.

Saver’s credit. The AGI limit to get the saver’s credit will be $56,500 for married couples filing jointly in 2011, up from $55,500 in 2010. For heads of household the income limit will increase from $41,625 this year to $42,375 in 2011. Single people and married individuals filing separately can earn up to $28,250 and still get the saver’s credit, up from $27,750 this year.

Continue reading at US News.com...

The New Threat To Your IRA: An IRS Crackdown

IRS rules and regulations surrounding IRAs frequently confuse taxpayers, but until now minor slip-ups were often overlooked or forgiven with a small fine. However, the IRS has been cracking down on IRA account holders lately. According to this Forbes.com article, you should be careful to avoid excessive IRS penalties.

After years of haphazard enforcement, the Internal Revenue Service is starting to systematically search out violations of the convoluted rules governing individual retirement accounts. There's a lot at stake. Americans hold $4.3 trillion in IRAs, and the cost of even innocent mistakes can be steep; if you miss taking a required payout from your IRA, Uncle Sam will demand half of the amount you forgot to take as a penalty.

The IRS was prodded to act by the Treasury Inspector General for Tax Administration. In a report earlier this year it concluded that IRA violations have been growing and estimated that more than half a million taxpayers either missed required payouts or contributed more than allowed to IRAs during 2006 and 2007.

"No one was auditing this stuff. Now the IRS is cracking down,'' says Seymour Goldberg, a Woodbury, N.Y. lawyer who serves on a committee of tax pros who meet with the IRS on pension issues. Here are some IRS targets and ways to keep your retirement stash out of its sights.

Missed Required Payouts

You put pretax money into a traditional IRA, where it grows tax-deferred. But Uncle Sam wants his cut eventually. So the law requires IRA owners to begin taking "required minimum distributions" from traditional IRAs after they turn 701/2. Roths work in reverse. You contribute already taxed cash to a Roth, and distributions are tax free. Owners of Roths, no matter how old, don't have to take RMDs. Nonspousal heirs of both traditional and Roth IRAs must generally take RMDs regardless of their age. To complicate matters, Congress suspended all RMDs for 2009 to give retirement accounts depleted by the 2008 market crash time to recover. But RMDs are back for 2010. That change will likely trip up additional taxpayers in 2010.

Continue reading here…

How to Stop the IRS Machine

Taxpayers all over the country are receiving letters from the IRS with unsettling news. According to Forbes, the IRS has been sending out bills to taxpayers because of discrepancies between their 2008 tax return and income totals reported by employers and other sources. However, before you reach for your checkbook, be sure to take a careful look at the notice. Many of the letters are reportedly incorrect and/or misleading.

Forbes.com reports:

It's document matching time at the Internal Revenue Service. Millions of taxpayers are opening their mailboxes to find a boldly stated notice shouting "Summary of Proposed Changes" identifying an increase to their 2008 taxes, penalties, interest and a whooping Proposed Balance Due. These notices are often more than 10 pages long, and not until you've gotten to page five do you find out what the IRS alleges created the problem: discrepancies between the amounts reported to them by others and what you included in your return. This is the meat of the letter (known as a CP-2000 notice) and often where you will find what led to the notice "mis-match."

Do not reach for your check book in defeat. Do not immediately scream obscenities about your tax preparer. These letters are often wrong. They are directed at getting your attention. They are machine-generated, generally unseen or untouched by human eyes or hands until the taxpayer responds to the notice. Until a response is received and logged in by IRS personnel, the machine will control the process. Uninterrupted, this automation will lead the IRS to be legally entitled to collection of the balance being proposed. Here are a few examples illustrating the variety of issues on notices I've seen recently:

Shock and Awe Proposed Balance Due: $54,871; Actual Balance Due: Zero

The IRS computers concluded the taxpayer had an IRA distribution of $198,981, but showed a taxable IRA distribution of just $40,000 on the return. The real story is this: The taxpayer converted a pre-tax IRA worth $198,981 to a Roth IRA early in 2008, and he correctly reported this as an IRA distribution on his 2008 return. The stock market dropped dramatically toward the end of 2008. Not willing to pay taxes on an amount well in excess of the account value in early 2009, he properly "re-characterized" (returned to his traditional IRA before filing) all but $40,000 of the converted amount, reporting that amount as taxable on the return. He correctly disclosed this and included Form 8606 on his return. It was all explained, but the IRS machines had not checked for those entries. (For 10 Reasons To Convert To A Roth IRA, click here.)

Shock and Awe Proposed Balance Due: $524; Actual Balance Due: Zero

The taxpayer authorized $2,000 of her 2008 IRA distribution to be donated to her local church. Her tax return correctly indicated a $21,690 distribution with $19,691 taxable. As the IRS instructions dictated, the code "QCD" (for qualified charitable distribution) was indicated on the return. But the IRS' "automated underreporter" systems apparently did not notice the code.

Read more here

15 most hated fees

Fees. No matter what they’re for, they are not very popular. Unfortunately, fees aren’t going anywhere. We will probably encounter more than the expected in the coming years. CNN Money discusses 15 fees we should be on the look-out for:

1. Forking over new charges for overdrafts: Often banks allow you to link a savings account to your checking account so that funds can be pulled from the former if you overdraw the latter. This workaround can help you avoid nonsufficient-funds fees, now averaging $30, according to Bankrate.com. But many banks have found a workaround for your workaround: They'll charge you $10 to $20 every time they transfer your money between the accounts. Meanwhile, it costs the bank next to nothing to move the funds, says Bryan Derman of Glenbrook Partners, a financial services consulting firm. "They're charging you for what's essentially an automatic transfer!" echoes reader Zoe Dowling, whose bank (Wells Fargo) levies the fee.

How to fight back: Sign up on your bank's website or Mint.com for e-mail or text-message alerts that tell you when your checking account balance is below a certain amount. That way, you can make transfers for free, yourself--before an overdraft is triggered.

2. Paying to use your frequent-flier miles: Can it really be called "reward travel" if you have to pay for the reward? To redeem your miles for any flight on US Airways, you must pay a $25 to $50 fee. ("It's an effort to recoup a portion of the overhead of the program," says spokesman Todd Lehmacher.) American, United, and Continental, among others, usually make you pony up $50 to $500 one way to use miles for upgrades.

How to fight back: Stick to one airline, and try to achieve gold or platinum status (which generally involves flying at least 25,000 miles a year). That way you'll escape redemption fees, says Randy Peterson of WebFlyer.com. Don't travel that much? Consider a credit card that lets you earn miles -- specifically "elite qualifying miles" -- such as Platinum Delta SkyMiles American Express (800-223-2670). Just be sure to weigh the annual fee against the benefit you'll get.

3. Paying to shut a brokerage account or IRA: No matter how unhappy you may be with your broker, you may be even more unhappy to discover that you'll have to shell out money to sever your relationship. Many of the major firms -- such as Fidelity, Schwab, and WellsTrade -- charge transfer fees, generally between $50 and $200, if you close your account and move your money to a different firm. Reader Eric Nix finds it "outrageous" that he had to lay out $50 to switch brokerages. Benjamin Poor of Cerulli Associates, a financial services market research firm, agrees. "It's like having a bad meal at a restaurant, then being charged to leave the building."

How to fight back: If your current brokerage is holding you hostage with its fee, appeal to the company where you want to move your funds. Many will reimburse you. To prevent these problems down the road, when you first sign up at a brokerage, ask that it waive such fees. "These things are negotiable, especially if you have a sizable account," says Mason Dinehart, a securities expert witness. (Sizable means six figures.)

4. Plunking down to hang up on your cell carrier: Agreeing to a cell phone contract is sort of like signing over your soul to the devil: You know there will be hell to pay if you break your end of the deal. In this case you'll owe $200 to $350. Such fees usually subsidize the cost of the handset you bought at a low price, says Bob Sullivan, author of Stop Getting Ripped Off.

How to fight back: Try to talk your way out of the fee, mentioning examples of poor service you've received (keep records and cite them). Customer rep won't budge? If you can stand it, stick with the carrier a while longer. Termination fees are generally pro-rated, so the longer you hold out, the less you'll pay. Next time consider a prepaid phone, which doesn't require a contract. It's generally a good deal if you use it less than 400 minutes a month during peak hours, says Sullivan.

See all 15 fees and how to fight back here.

Retiree Annuities May Be Promoted by Obama Aides

According to Bloomberg.com, the Obama administration is considering how the government can encourage workers to turn their savings into guaranteed income streams following a collapse in retiree accounts when the stock market plunged.

The U.S. Treasury and Labor Departments will ask for public comment by next week on ways to promote the conversion of 401(k) savings and Individual Retirement Accounts into annuities or other steady payment streams, according to Assistant Labor Secretary Phyllis C. Borzi and Deputy Assistant Treasury Secretary Mark Iwry, who are spearheading the effort.

Annuities generally guarantee income until the retiree’s death, and often that of a surviving spouse as well. They are designed to protect against the risk that retirees outlive their savings, a danger made clear by market losses suffered by older Americans over the last year, David Certner, legislative counsel for AARP, said in an interview.

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Roth IRA Change May Not Be ‘Game Changer’ for Savers

Earlier today I came across this fascinating article from Bloomberg.com, discussing the changes to the US tax code that would allow more taxpayers to convert to a Roth IRA. In the article, the author discusses how changing may not make as big of a difference as one would think, and provides several examples of why.

Changes to U.S. tax laws next year give high-income earners planning for retirement a decision to make: pay now or pay later.

Taxpayers making more than $100,000 a year in adjusted income will be allowed to convert to Roth IRA accounts from traditional IRAs after that limit is lifted at the end of the year. That means 16 million Americans, according to tax returns filed with the Internal Revenue Service in 2007, can consider whether they want to make tax-deductible contributions if they have a traditional IRA or pay the taxes up front and have tax- free withdrawals during retirement with a Roth IRA.

Which is better depends on future tax rates and how much the conversion will cost. It may not make sense to pay taxes today at a higher rate because many investors will be in a lower tax bracket during retirement, according to Tom Orecchio, a fee-only adviser at Modera Wealth Management in Old Tappan, New Jersey.

“From a tax perspective, I think when people do the math, it’s not going to be as game changing as they expect it to be,” Orecchio said.

Higher-income households that could benefit from the income limit changes are not rushing to switch, according to a survey released today by San Antonio-based United Services Automobile Association. The national survey of 1,259 adults between 45 and 64 years of age shows that for those with an IRA and a household income of $100,000 or more, 9 percent are planning to convert in 2010.

Tax Assumptions

Most IRA assets are held in traditional IRAs, based on a June report by the Investment Company Institute, a Washington- based trade group for mutual funds. Investors held $3.2 trillion, or 89 percent of IRA assets, in traditional IRAs at the end of 2008. Roth IRAs accounted for $165 billion, or 5 percent, of all IRA assets.

Continue reading here…

Converting an IRA into a Roth? How's Your Crystal Ball?

Ron Lieber of the New York Times recently published an article discussing the unpredictable future of Roth IRAs. At one point, Lieber even proposes the possibility of taxes on withdrawals from Roth IRAs. Lieber predicts that “at the most extreme end, the federal government might try to tax the earnings on a Roth after all, say through the capital gains tax, which is currently at 15 percent for long-term gains but could go up in the next few years.”

You’ll be hearing a lot in the next six months about Roth Individual Retirement Accounts — but not as much as you should about a long-term threat that hangs over them.

Starting Jan. 1, you’ll be able to take a regular IRA, say, one that you have in a brokerage account after having rolled an old 401(k) into it, and turn it into a Roth. You’ll be able to do this no matter how much money you make, though you’ll have to pay income taxes at your current rate on whatever you move. Currently, you can’t make the conversion at all if your household has more than $100,000 in modified adjusted gross income. (That’s a technical Internal Revenue Service term, which it defines in Publication 590, available on its Web site).

Why would you want to make such a swap? Because you think you or your heirs could end up with more money over the long haul by investing in a Roth instead of a regular IRA.

With a Roth IRA, you pay no taxes on your earnings in most instances when you take money out; distributions from regular IRA’s are taxable the same way that income is, though the basic IRA does offer a tax deduction when you first deposit money into the account. The Roth offers no such deduction when you contribute money to it.

So if you think your tax rate will be higher during retirement than it is now, say if you’re fairly young for instance, making the conversion early in 2010 looks sensible.

Continue reading here…

Timing May Never Be Better On Roth IRA Conversions

From the ChicagoTribune.com:

Joe Cunningham is convinced that income taxes are going up, even for middle-class people like him.

Attempts to fix the economy can't work without an enormous tax increase, the Pasadena, Md., retiree said: "It will be on everybody who pays taxes, which ultimately always is the working class or retired working class."

For that reason, the 68-year-old wants to convert his traditional individual retirement account to a Roth IRA. By doing so, he'll have to pay regular income tax now on the funds he transfers to the Roth. But from then on, money coming out of the Roth will be tax-free. So no matter how high taxes go, Cunningham won't have to worry.

If he's right about taxes, his timing to convert couldn't be better.

Tax rates are historically low now. IRA account values also have fallen with the markets, so there are fewer gains to tax during a conversion. And the outlook for higher federal income taxes is good--at least for those in the top two brackets. President Barack Obama favors raising the rates on families making more than $250,000. Even if Uncle Sam doesn't raise income taxes on those making less than that, cash-strapped states might do so, said Ed Slott, an accountant and IRA expert. That's another factor favoring the Roth.

IRAs give you the choice of receiving a tax break upfront or on the back end.

A traditional IRA rewards you on the front end, where contributions often are deductible. Once you take money out in retirement, you pay regular income tax on the earnings and any deductible contributions.

Money goes into a Roth after taxes have been paid on it, but comes out tax-free in retirement. Basically, you're better off with a Roth IRA if you expect to be in a higher tax bracket in retirement than while working.

So should you, like Cunningham, make the switch?

There are several factors, besides the tax outlook, you need to consider.

Right now, only singles and married joint filers with adjusted gross incomes up to $100,000 can convert a traditional IRA into a Roth. Next year, that cap disappears. And if you convert to a Roth IRA next year only, you will be able to spread the tax bite over 2011 and 2012.

You shouldn't convert if you will need to take the money out of the Roth within five years. If you do so, you will trigger taxes on the earnings withdrawn, Slott said. Plus, you can be hit with a stiff penalty if you're under age 591/2.

"There is really no benefit today, or next year or two years" for converting, said Jim Sloan, a financial adviser in Friendswood, Texas. "The benefits are five, 10 or 15 years from now" when your Roth has had time to grow, he said.

Don't convert if you don't have money outside the IRA to pay your tax bill. Using IRA cash to pay taxes means fewer dollars going into the Roth. Plus, that cash will be subject to an early withdrawal penalty if you're under age 591/2.

As an alternative, you could convert only part of your IRA to reduce the tax bite to an amount you can afford to pay out-of-pocket, Slott suggested. For retirees who don't need the money, the Roth has another attractive feature: No required distributions after age 70 1/2.

To see whether a conversion makes sense for you, check out the Morningstar IRA calculator on T. Rowe Price Associates' Web site (troweprice.com). Click on "individual investors," then "tools and calculators."

Of course, there is no guarantee taxes will go up.

That's why Joel Dickson, a tax expert with the Vanguard Group, recommends a mix of traditional and Roth IRAs as a hedge against whatever happens to tax rates.

If you regret converting, you have a certain amount of time to switch the Roth back to a traditional IRA and have the money you paid in taxes returned, Slott said. You will need to contact the custodian of your IRA and file Form 8606 with your federal tax return to convert, Sloan said.

IRAs are highly complicated. There are so many potential traps that if you're not quite sure how to undertake a conversion, seek the help of a professional.

Take a Look At Tax Law When Converting An IRA

The News Tribune recently published a great article examining the tax laws surrounding the conversion of a Traditional IRA to a Roth IRA. You can check out a portion of the article below, but the full post can be found here.

Over the next two years, you are likely to see more people convert assets from Traditional Individual Retirement Accounts to Roth IRAs.

Three considerations make understanding the IRA to Roth conversion more important for many investors:

• Lower values of most IRAs as a result of the market correction.

• The prospect of increased taxes in our future.

• The elimination of an income limit in 2010.

With a Traditional IRA, when you take withdrawals of your contributions and earnings, they are subject to ordinary income tax. Also, once you reach 701/2 you are forced to take annual distributions. (These required minimum distributions have been waived for 2009.)

With a Roth IRA, as long as you’re over 591/2 and have held the account for five years, the assets grow tax free, there’s no tax on withdrawals and no requirement to take annual distributions if you don’t need the income. This way, more potential growth may be available for your later years or for beneficiaries of the account.

Determining whether or not to make this conversion can be complicated. You need to weigh the short-term consequences vs. the long-term impact. In order to make the conversion, you have to pay income tax on the amount converted. But if you can afford that hurdle, the long-term benefits may be worthwhile.

For many, a Roth conversion makes sense if you expect income tax rates, or those of your heirs, to rise. An increasing personal tax burden seems likely given the rapidly growing fiscal deficit due to bailout and economic stimulus packages.

There are different reasons driving Roth conversion decisions in 2009 and 2010. This year, investment declines during this recession have presented a more immediate opportunity. If your modified adjusted gross income is less than $100,000 in 2009 (filing jointly or single), you are eligible to make the move from Traditional to Roth IRA. And for many, the tax bill associated with the conversion will be significantly less than it would have been to make the same conversion at this time last year.

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IRS Issues Spring 2008 Statistics of Income Bulletin

Late last week the IRS released the Spring 2008 issue of the Statistics of Income Bulletin. The document features data from the 138.4 million individual tax returns filed for the 2006 tax year and data from high-income returns filed for the 2005 tax year.

According to the IRS announcement, the bulletin also features articles on the following:

• Trends in non-cash charitable contributions, including a big drop in car donations in 2005 that was likely related to tax law changes.
• Statistics on cash flows and holdings of Individual Retirement Accounts (IRAs). For example, at the end of 2004, almost 51 million taxpayers held roughly $3.3 trillion in IRAs.
• Repatriation of funds by U.S. corporations due to the one-time received dividend deduction enacted in the American Jobs Creation Act of 2004.
• Statistics on federal estate tax returns with gross estates greater than $1.5 million.
• Growth in the number and assets of taxable Real Estate Investment Trust subsidiaries.

To see all the information presented in the bulletin, check out it’s page on IRS.gov.